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Uncreative Destruction

Posted By Russ Roberts On January 5, 2007 @ 12:48 pm In Work | Comments Disabled

In a comment to my recent post on the empirical literature, Spencer writes:

In the dynamic, flexible, very high turnover job market as it exists at
the lower end of the US job market a 1% to 3% job loss from a higher
minimum wage is insignificant and is less then the rounding error. The
data says that in our dynamic economy the individuals displaced by a
higher minimum wage have no trouble finding other employment. The
difference in our assessment is you assume that the displaced employees
become permanently unemployed. But that is just not the case in the US
economy.

I have read many of the articles on the minimum wage, but it was long ago. But yes, my guess is that they do find that the losses in employment of 1%-3% from a minimum wage are permanent. In fact, in the earlier literature, there was a finding that people who lost their job from an increase in the minimum wage would find employment in the "uncovered" sector, the sector that didn’t have a legal requirement to pay a minimum. The main occupation in that sector was crime.

So unlike creative destruction, the normal turnover in businesses and employment that comes from innovation and competition and that is ultimately a healthy part of economic life in America, an increase in the minimum wage that destroys jobs is uncreative destruction—it comes from a mandated legal restriction. Job losses caused by uncreative destruction are not easily replaced. Here’s why.

Suppose the federal government mandated that all instructors at George Mason receive a 40% raise. Should I be happy or sad? Happy, of course, you might think, especially because I have tenure. How about assistant professors without tenure? Some of them would have their contracts not renewed. Others would find their teaching loads increased by their department chairs.

But even some tenured full professors might lost their jobs. How? Their departments would be shut down at the university as being no longer viable in this new world. (I’ve seen it happen, folks, even without a federal mandate.) It is conceivable that the Virginia legislature might decide to close some schools in the state university system as a result of the higher costs. So while some professors might end up with much higher salaries as a result of the mandated increase, many others, of all different levels, would be out of a job. Tuition would certainly rise. These are all the standard effects of the minimum wage.

Of course, the mandate might work more like the minimum wage. It might just require a 40% increase in the salaries of the lowest paid professors. Then surely, they would feel the biggest brunt of the mandate.

You might argue that it won’t be so bad. You might be one of the lucky ones who keeps his or her job. You get a huge raise! And if your contract isn’t renewed? So what? You can always go out and find a new job.

But what if ALL the universities, nation-wide have to pay higher salaries? That dynamic job market isn’t so dynamic any more. There aren’t just going to be fewer opportunities in Virginia. There are going to be fewer opportunities everywhere. Every college is going to be cutting back.

That’s what the minimum wage does to low-skilled people. It reduces the chance of finding a job everywhere.

Do the same experiment with your occupation. If you lost your job today because your employer did a bad job running the company, you’d be distressed and you might struggle to find another job for a while. But you’d find one. It might pay a little more, it might pay a little less, but you could probably find a job with similar pay and benefits.

But suppose you lose your job because the federal government mandates a 40% increase in wages for your type of job and now your employer finds that you’re no longer worth keeping around at that price. Do you think it’s going to be easy finding a new job at a new employer who is also required to pay that 40% premium above your old job. Not only are there going to be fewer jobs open for people with your skills, but you’ll be competing for those jobs with all the other laid-off workers like you whose boss cut them lose or had to close up after the cost increase. And guess what? When you find that new job, you’ll take it even if you have to work more hours than you did before, get less on-the-job training and have to provide your own uniform. And you’ll pretend to like it because you don’t want to get laid off again, knowing how hard it is to find a new job.

Minimum wages are uncreative destruction.

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